1. Corporate Financial Theory
Lecture 9

2. Megers & Acquisitions Three Areas of Study
Determining if a Merger creates value (then developing an offer price)
Evaluating M&A offers in the market place (your case analysis assignment)
M&A Strategies (biggest area of “talk”)
Today - Cover both
Part 1 & 3 via lecture
Part 2 via example

3. Recent Mergers

4. Bank of America Family Tree
Note: Ironically, MBNA was once owned by a previous version of Bank of America, which sold it in an IPO.

5. Mergers

6. Sensible Reasons for Mergers
Economies of Scale
A larger firm may be able to reduce its per unit cost by using excess capacity or spreading fixed costs across more units. $
Reduces costs $ $ 11

7. Sensible Reasons for Mergers
Economies of Vertical Integration
Control over suppliers “may” reduce costs.
Over integration can cause the opposite effect.
Pre-integration (less efficient)
Company S
Post-integration (more efficient)
Company S 14

8. Sensible Reasons for Mergers
Combining Complementary Resources
Merging may results in each firm filling in the “missing pieces” of their firm with pieces from the other firm.
Firm A
Firm B 16

9. Sensible Reasons for Mergers
Mergers as a Use for Surplus Funds
If your firm is in a mature industry with few, if any, positive NPV projects available, acquisition may be the best use of your funds. 17

10. Dubious Reasons for Mergers
The Bootstrap Game
Acquiring Firm has high P/E ratio
Selling firm has low P/E ratio (due to low number of shares)
After merger, acquiring firm has short term EPS rise
Long term, acquirer will have slower than normal EPS growth due to share dilution. 22

11. Dubious Reasons for Mergers
Boot Strap Game
Diversification
Investors should not pay a premium for diversification since they can do it themselves.
Excuse to change capital structure 18

12. Dubious Reasons for Mergers
The Bootstrap Game 22

13. Dubious Reasons for Mergers
Earnings per dollar invested (log scale)
World Enterprises (after merger)
World Enterprises (before merger)
Muck & Slurry
.10
.067
.05
Time
Now 22

14. Sensible or Dubious
Other People’s Money
Additivity Principle

15. Estimating Merger Gains
Q: If M&A creates value, Why?
A: Synergies
-Admin
-Dup services
-lower COC 24

16. Estimating Merger Gains
Questions
Is there an overall economic gain to the merger?
Do the terms of the merger make the company and its shareholders better off?
???? 23

17. Estimating Merger Gains

18. Estimating Merger Gains
Example – Two firms merge creating $25 million in synergies. If A buys B for $65 million, the cost is $15 million.

19. Estimating Merger Gains
Example – The NPV to A will be the difference between the gain and the cost.

20. Estimating Merger Gains
Q: How Much Should A Firm Pay in a M&A?
A: Theory
Gain = PVAB - (PVA + PVB)
A must pay B part of the gain
A: Reality
A usually pays B all of the gain, plus more.
Why?
Premium Paid by A = (Cash - MVB) + (MVB - PVB) 24

21. Sell or Don’t Sell ?
Other People’s Money
Board Meeting

22. Takeover Methods Type of Takeovers Hostile Friendly LBO Going Private
Greenmail
White Knight 9

23. Tools Used To Acquire Companies
Takeover Methods
Tools Used To Acquire Companies
Proxy Contest
Acquisition
Tender Offer
Leveraged Buy-Out
Management Buy-Out
Merger 9

24. Takeover Defenses
White Knight - Friendly potential acquirer sought by a target company threatened by an unwelcome suitor.
Shark Repellent - Amendments to a company charter made to forestall takeover attempts.
Poison Pill - Measure taken by a target firm to avoid acquisition; for example, the right for existing shareholders to buy additional shares at an attractive price if a bidder acquires a large holding. 28

25. Takeover Defenses

26. Classic Video
Wall Street
Board Meeting

27. M&A Who Usually Benefits from M&A? Shareholders of B Lawyers & Brokers
Execs in A
Who Usually Losses in M&A?
Shareholders of A
Execs in B
Employees

28. M&A Analysis Steps for M&A Market Analysis
Briefly describe the financial & strategic history of the company
Determine pre-announcement value
Describe M&A offer
Determine merged value (examine synergies)
Compare values, offer, & market prices
Predict success of M&A
Recommend a strategy for investors and shareholders
Provide a summary analysis

29. M&A Analysis History - News, Annual Report, 10k, etc.
(Library & My Web page)
(use spreadsheets to present financial facts)
(reference your sources)
(present both original & summary data)
(remember to annualize data)
Submit electronically
Excel file only
Named: Last Name in File Name

30. Disney / Cap Cities Deal
Announcement of Offer
Disney offers to acquire Cap Cities/ABC.
Disney will exchange each share of Cap Cities for one share of Disney plus $65 cash.
Disney will issue $10bil in new debt to finance the deal.

31. Fact Sheet ** Disney Market Rd 7.25% 8.0 %
EPS $ 2.50 $ 2.33
Forecasted 14% growth rate
Forecasted EPSx#New Shares

35. Probabilistic Analysis: Monte Carlo Simulation
Suppose we allow several assumptions to vary. What is the resulting distribution of the DCF value of equity?
Sales growth years 1–3: 14%–17%
Sales growth years 4–7: 5%–7%
Operating cost/sales: 41%–49%
Personnel cost/sales: 13%–17%
Receivables/sales: 15%–18%
Accounts payable/sales: 15%–18%
Other payables/sales: 15/18%